Suryoday Small Finance Bank IPO – Invest or avoid?

Risks

#1 Presence in high-risk segments

Suryoday has reduced its exposure from the high-risk, high returning segment of micro finance, from 95% of advances in FY-18 to 76% for the nine months ending December 2020. But this segment remains the primary growth and profit driver. While much of this lending is unsecured, Suryoday claims that its unique approach of forming ‘joint liability groups’  where group loans are disbursed on peer-guarantee model helps ensure better credit discipline. The target customers are women and interest is anywhere between 20-26%. While this model may seemingly mitigate risk, there are factors that offset this. For one, such loans may well be consumption loans than business loans, going by the ticket size of Rs 10,000- 52,500. Second, the urban and semi-urban population has been more hit by loss of income during the pandemic and this is the predominant segment for Suryoday, thus heightening default risks. Markets too tend to perceive MFI focussed SFBs as far riskier than those with other exposure.

Assuming Suryoday does diversify further away from this segment, as have many SFBs, the high margins enjoyed now may not sustain. Segments such as commercial vehicle loan in the lower income space, are also traditionally prone to high NPAs. Ujjivan, which has a similar advance profile commands around 1.8-times book value, a discount to the asking price by Suryoday.

#2 CASA needs shoring up

For SFBs, diversification in product profile away from high yield microfinance reduces risks but also shrinks NIMs.  The main way to keep margins from sliding significantly would be to keep cost of funding low. And that is achieved through CASA (deposits through current account and savings account). This is one reason why so many small finance banks are keen to get you to open a savings account with them!

On this front, Suryoday has a long way to go. Data below shows how peers are ahead of the bank in terms of their ability to attract CASA. Suryoday would need to attract low cost deposits to keep its cost profile attractive, even as it diversifies its loan mix.

#3 Geographic risks

Maharashtra, Tamil Nadu, and Odisha account for 77% of the gross advances of Suryoday. This concentration needs to come down. Peers like Ujjiivan SFB for instance has under 45% exposure to their top 3 states of Tamil Nadu, Karnataka, and West Bengal. At a time when loan waivers are in vogue, exposure to election bound States like TN can pose risks should populist policies destroy credit culture. Politically populist measures can impact asset quality more, when the portfolio is concentrated.

#4 Asset quality risk looms

With Covid hitting incomes and regulators extending special dispensations, markets have begun to focus on asset quality to the exclusion of most other parameters in valuing banking stocks.  Post the moratorium granted to borrowers (extended till August 31, 2020), declaring accounts as NPAs has been kept on hold by the Honorable Supreme Court of India. As a result, most banks have not provided for their bad loans in full in their published results. Had Suryoday classified borrower accounts as NPAs post August 31, 2020, its gross NPA ratio would have been 9.28% on a proforma basis. This is a significant jump over its declared NPA of 0.78% and is alarmingly high when compared with peers.

These off-book NPAs could require higher loan loss provisions and dent profits in the coming quarters once the moratorium is lifted. While Suryoday has capital buffers to absorb this it’s profit and growth metrics can suffer.

This risk appears heightened given the micro finance-heavy segment profile of Suryoday. The bank has stated that it holds a Covid-19 related buffer of Rs 140 crore (3.7% of loan book). Collections (as measured by number of paying customers) for Suryoday  has improved from 42% in June 2020 to 82% in December 2020 but was higher at 95% for Ujjivan SFB in December 2020.

Valuation and recommendation

On a post-issue basis, Suryoday will trade at 2.1 times its book value at the upper end of the price band. This is not too high. But it needs to be kept in mind that barring AU Small Finance Bank, all other SFBs have seen a derating of  in their valuations post listing, especially post Covid. The only exception being AU, for its zero presence in the risky micro-finance segment. Ujjivan SFB is currently at 1.8 times book. But what needs to be remembered is that its advances is 3.5 times that of Suryoday’s, and deposit at 3.8 times.

We would rather wait to see a higher product/geographic diversification from Suryoday and the true picture on NPAs; besides, see SFBs take a one-time hit on their balance sheets when the Covid-19 related bad loans are eventually written off (once Supreme Court gives the signal). The risk-return payoff may be better then.